||07-04-2008 10:07 PM
Re: Raping Us at the Gas Pumps!
The price of oil and other commodities is all simple supply and demand.
Tired of high gasoline prices and rising food costs? Well, here's a solution. Let's shoot the "speculators." A chorus of politicians, including John McCain, Barack Obama and Sen. Joe Lieberman, blames these financial slimeballs for piling into commodities markets and pushing prices to artificial and unconscionable levels. Gosh, if only it were that simple. Speculator-bashing is another exercise in scapegoating and grandstanding. Leading politicians either don't understand what's happening or don't want to acknowledge their complicity.
Granted, raw-material prices have exploded across the board. Look at the table below. It shows price increases for eight major commodities from 2002 to 2007. Oil rose 177 percent, corn 70 percent and copper 360 percent. But that's just the point. Did "speculators" really cause all these increases? If so, why did some prices go up more than others? And what about steel? It rose 117 percent—and continued increasing in 2008—even though it's not traded on commodities futures markets.
A better explanation is basic supply and demand. Despite the U.S. slowdown, the world economy has boomed. Since 2002, annual growth has averaged 4.6 percent, the highest sustained rate since the 1960s, says economist Michael Mussa of the Peterson Institute. By their nature, raw materials (food, energy, minerals) sustain the broader economy. They're not just frills. When unexpectedly high demand strains existing production capacity, prices rise sharply as buyers scramble for scarce supplies. That's what happened.
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<!--AD END--> "We've had a demand shock," says analyst Joel Crane of Deutsche Bank. "No one foresaw that China would grow at a 10 percent annual rate for over a decade. Commodity producers just didn't invest enough." In industry after industry, global buying has bumped up against production limits. In 1999, surplus world oil capacity totaled 5 million barrels a day (mbd) on global consumption of 76mbd, reckons the U.S. Energy Information Administration. Now the surplus is about 2mbd—and much of that in high-sulfur oil not wanted by refiners—on consumption of 86mbd.
Or take nonferrous metals, such as copper and aluminum. "You had a long period of underinvestment in these industries," says economist John Mothersole of Global Insight. For some metals, the collapse of the Soviet Union threw added production—previously destined for tanks, planes and ships—onto world markets. Prices plunged as surpluses grew. But "the accelerating growth in India and China eliminated the overhang," Mothersole says. By some estimates, China now accounts for 60 percent to 80 percent of the annual increases in world demand for many metals.
Commodity-price increases vary, because markets vary. Rice isn't zinc. No surprise. But "speculators" played little role in the price run-ups. Who are these offensive souls? Well, they often don't fit the stereotype of sleazy high rollers: many manage pension funds or university and foundation endowments. Their modest investments in commodities aim to improve returns.
These extra funds might drive up prices if they were invested in stocks or real estate. But commodity investing is different. Investors generally don't buy the physical goods, whether oil or corn. Instead, they trade "futures contracts," which are bets on future prices in, say, six months. For every trader betting on higher prices, another is betting on lower. These trades are matched. In the stock market, all investors (buyers and sellers) can profit in a rising market and all can lose in a falling market. In futures markets, one trader's gain is another's loss.
Futures contracts enable commercial consumers and producers of commodities to hedge. Airlines can lock in fuel prices by buying oil futures; farmers can lock in a selling price for their grain by selling grain futures. What makes the futures markets work is the large number of purely financial players—"speculators" just in it for the money—who often take the other side of hedgers' trades. But all the frantic trading doesn't directly affect the physical supplies of raw materials. In theory, high futures prices might reduce physical supplies if they inspired hoarding. Commercial inventories would rise. The evidence today contradicts that; inventories are generally low. World wheat stocks, compared with consumption, are near historic lows.
Recently the giant mining company Rio Tinto disclosed an average 85 percent price increase in iron ore for its Chinese customers. That was stunning proof that physical supply and demand—not financial shenanigans—are setting prices: iron ore isn't traded on futures markets. The crucial question is whether these price increases are a semi permanent feature of the global economy or just a passing phase as demand abates and new investments increase supply. Prices for a few commodities (lead, nickel, zinc) have receded. Could oil be next? Barron's, the financial newspaper, thinks so.
Politicians now promise tighter regulation of futures markets, but futures markets are not the main problem. Physical scarcities are. Government subsidies and preferences for corn-based ethanol have increased food prices by diverting more grain into biofuels. A third of the U.S. corn crop could go to ethanol this year. Restrictions on offshore oil exploration and in Alaska have reduced global oil production and put upward pressures on prices. If politicians wish to point fingers of blame for today's situation, they should start with themselves.
Taken from Newsweek- Speculators to Blame for High Commodity Prices? | Newsweek Voices - Robert J. Samuelson | Newsweek.com